Speculation that the U.S. Federal Reserve is set to fire up the U.S.-dollar printing press has heightened the already fervent interest in precious metals investments. A look at the relationship between global money supply and the gold price suggests the interest is justified.
The chart on the left shows the year-over-year change in the gold price in U.S. dollars vs. a weighted average of money supply growth for the euro zone, U.S., China, Japan, India and Britain. (Combined, these countries account for 68 per cent of global gross domestic product, according to the International Monetary Fund.)
Between 2000 and 2006 the relationship makes perfect sense – gold's price moved in line with the growth of global money supply (the correlation is 0.65, for those scoring at home). This supports the traditional view of gold as the anti-currency, a form of wealth that maintains its spending power while paper currencies are devalued by the printing of more money.
However, the connection between the gold price and global money supply broke down before and during the financial crisis. The reasons why can be debated, but the point remains that while central banks embarked on an unprecedented spree of printing money during and after the crash, the gold price declined in year-over-year terms.
The historic trend appears to reassert itself in mid-2010. Volatility for both money supply and the gold price declined and the significant August spike in money supply was matched by a jump in the bullion price. Correlation, which was negative through the crisis, has turned positive to 0.35 since 2010.
Our chart is only one piece of the puzzle and clearly not the basis for an investment decision by itself. But, with the Fed expected to announce further measures to increase U.S. money supply Wednesday, the re-establishment of a connection between the gold price and money supply would be an important and bullish indicator for investors in the sector.
Scott Barlow